28 Jul THE SCHUHMACHER CORPORATION HAS DEBT OUTSTANDING. THE TOTAL AMOUNT
The schuhmacher Corporation has debt outstanding. the total amount that it will have to pay to bondholders in one year’s time at date 1 is $100 million. The firm’s position since it issued the debt five years ago has steadily deteriorated. Its only remaining asset is $25 million in cash. If it does nothing the bondholders will receive all the cash and any interest the cash might earn. The Firm has the option to undertake one of the following projects. PROJECT A: Cost at date 0= $25 million. Payoffs at date 1= $200 million with probability 0.05 and 0 with View complete question » The current date is date 0. The schuhmacher Corporation has debt outstanding. the total amount that it will have to pay to bondholders in one year’s time at date 1 is $100 million. The firm’s position since it issued the debt five years ago has steadily deteriorated. Its only remaining asset is $25 million in cash. If it does nothing the bondholders will receive all the cash and any interest the cash might earn. The Firm has the option to undertake one of the following projects. PROJECT A: Cost at date 0= $25 million. Payoffs at date 1= $200 million with probability 0.05 and 0 with probability 0.95. PRJOECT B: Cost at date 0= $25 million. Payoffs at date 1= $50 million with probability 0.6 and $30 million with probabiltity 0.4. The risk of both projects is such that an applicable discount rate is the risk free rate of 10%(i.e. all the risk is unique risk.) Questions (a) what are the date 0 NPV’s of projects A and B? (b) what are the present values of the debt and equity of the firm at date 0 if it commits to (1) reject both project A and B and put $25 million cash in the bank at 10% (2) accept project A (and reject B) (3) accept project B(and Reject A) (c) if the firm operates in the interest of the shareholders which strategy (i.e (1)(2) or (3) in Part B will be chosen?
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